India May Soon Boot Out as a BPO-Perfect Nation
Arindam Mukherjee
Outlook India
May 28, 2007

At least one leg propping up the Indian BPO success story is buckling under the reality vs hype pressure.

The coming months may see a slightly pessimistic chapter written as part of the Great Indian Offshoring Tale. There will certainly be a shakeout as business process outsourcing, where western firms shift operations to fully-owned units in low-cost hubs like India, becomes less attractive to global players. India's sunrise service sector may well see the setting sun soon.

If you think we are exaggerating, here's a reality check from Forrester Research. In the last few months, several leading MNCs have shut down their Indian captive centers. A clutch of global firms like GE, British Airways and Citibank have already sold off their BPO subsidiaries. And others like Microsoft, Cisco and Texas Instruments are outsourcing the less critical work to third parties, instead of their Indian campuses. The bitter truth is mncs are increasingly logging off from India.

Several studies indicate that a majority of MNC-managed captive centres—in areas like product engineering, R&D, IT and other BPO services—are facing grave problems. Agrees Sudin Apte, senior analyst & country head (India), Forrester Research, which came out with a report, 'Shattering The Offshore Captive Center Myth', last month: "Over 60 per cent of the captive centers are struggling due to lack of management support, spiralling costs, attrition and integration issues."

A report by Zinnov, a US-based firm, states that while global IT firms set up internal campuses in India because of factors like cost savings, availability of a rich talent pool and capability to execute large projects, the reality was different. Explains Pari Natarajan, CEO and co-founder, Zinnov: "In the last 12 months, there has been a tremendous cost escalation for manpower and infrastructure. This is making it difficult for global firms to run small operations profitably."

Initially, when the MNCs decided to set up captive units, they underestimated India's cost structure and, hence, the operational expenses. What's more, consultants puffed up projections, keen as they were on overselling the India BPO and offshoring story. As an analyst in a leading IT firm says, "Many consultants just wanted to get the projects to India, and overindulged in their estimates."

Such calculations, feels Forrester Research, led global firms to believe that there were savings to be made not just in skilled labour, but everything else like infrastructure and other fixed costs.

Thus they thought that actual savings were much higher. A double whammy hit them when costs rose sharply in the past two years. For instance, salary hikes are among the highest in software and BPO segments and real estate prices have zoomed even in the small towns.

Apple officials contend that the decision to close down the company's captive unit in India was taken at the US headquarters. They admit that the company—in true Apple style—hired people from the higher levels, matching their salaries, which were quite fat. But, as one of the officials says, "somewhere down the line, they realised that sustaining it would be a problem. So before it could take off, it was called off." The officials add most of Apple's support and services work has been handed over to Transworks.

Explains a spokesperson at Motorola which, according to Forrester Research, is using third parties for least-strategic work. "We have consistently developed India as a global R&D hub since '91, long before it became fashionable. And there has never been a slant on outsourcing work to India because of cheap scientific manpower. We are, therefore, markedly different from anyone else in this space. India is, and will continue to be, a key centre for its high-end R&D operations globally." Reason: it wants to rigidly control sensitive operations, but finds it unattractive to manage low-end ones.

While costs are important, there are other factors forcing a rethink among mncs. One, India has a high rate of attrition, coupled with low productivity levels. A recent Nasscom study on IT and IT-enabled services (like BPO and call centers) found that the annual attrition rate is as high as 30 per cent. Industry experts point out that attrition rates in MNC-owned captive centres are higher at 30-40 per cent. This makes it more expensive for MNCs as they have to either keep a huge bench (a waiting pool) or consistently hire HR consultants to hire new sets of employees.

Productivity too is low in Indian units, when compared to nations where the mncs are headquartered. According to Zinnov, staff productivity at offshore centres like in India is 50-60 per cent lower than that at the onsite units located in parent countries. Explains Natarajan: "For many firms, there's a mismatch in the productivity between their Indian and US teams." Experts add that captive units are further burdened with a poor delivery record, operational problems, a lack of scale and poor morale.

All the same, the champions of offshoring don't see any cause for concern. Says a confident Kiran Karnik, president, Nasscom: "There is no generic issue for captive centres to shut down. A few of them have because of reasons specific to them, and which doesn't make us uncomfortable. Some countries like the Philippines, South Africa and Vietnam have cost advantages. But if you look at other important factors like quality of service, flexibility, data protection and ability to scale up, India is way ahead."

Raman Roy, CMD, Quatro BPO Solutions, who's also considered to be the initial writer of the Indian BPO story, feels the gap between the US and Indian salaries is actually growing, and not narrowing. He adds that "productivity concerns are not true" and the Indian levels "are quite high". But both Roy and Karnik accept that the time taken to achieve certain benchmarks may be more because of the "larger training time" or "the time taken for the learning curve to set in". But they don't see it as a major issue.

More importantly, Roy says there is no need to worry as the captive centre model is undergoing a change. "It is giving way to third-party outsourcing as it is a better model that's available at a lesser cost," he explains. According to him, British Airways, GE, American Express and Apple have adopted this model."Looking ahead, it is clear that multiple models will coexist but the predominant one will be the third-party one." Therefore, offshoring will continue as the work will go to other Indian firms.

But that may not turn out to be the full plot. In the near future, predicts the Forrester Research report, 10 per cent of the MNCs' captive units will shut down, 20 per cent will adopt a hybrid approach by using third parties for less critical work and outsource strategic work to their Indian campuses, 10 per cent will sell out and completely give out work to third parties, and almost 50 per cent were likely to follow a "termite strategy", that's go slow on their plans and gradually exit.

The last category can then outsource its operations to any other country, which may emerge as a competitor to India. Already, East Europe, East Asia and China are emerging as threats vis-a-vis costs. More importantly, Russia is perceived to be more productive than India. Says a senior manager who has worked in both countries: "Russia is where India was a few years ago. At that time, Indians worked harder, for more hours, and at low salaries. Today, Indians think they can command any price."

So, will India's outsourcing narrative end like Ireland's, which lost out? Or will it turn out to be like Israel, which quickly climbed up the value chain to offer quality services and, obviously, earned unbelievable margins?

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